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Contents
SC&H Business Valuation & Support Leaders 
Michael J. Young, 
Nathan E. DiNatale,
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Valuations Insights, July, 2010 Valuing Goodwill in Divorce: Communication and Consistency are Critical Two recent divorce decisions demonstrate how important communication among the client, counsel, and financial expert(s) can be in any given case, especially when the primary asset is a professional practice. Calculating a credible goodwill value requires the expert to have adequate disclosures, accurate data, and a complete understanding of appropriate methodologies. Husband's expert gets a surprise at trial. In re Marriage of Theurer, 2009 WL 3823648 (Cal. App.)(Nov. 17, 2009)(unpublished) considered a well-established orthodontist with 14 people on staff, all the latest technology, and up to 150 patients per day. The practice grossed $2.6 million, earning the husband $1.3 million before tax. Notably, he averaged 921 new patients per year—more than three times the average. At trial, the wife's expert used the excess earnings approach, estimating the husband's reasonable compensation at $500,000, a goodwill value of $2.5 million and an overall practice value of $3.0 million. Similarly, the husband's first expert used the earnings approach, but applied a lower cap rate and higher compensation ($776,000) to reach a goodwill value of approximately $990,000, plus tangible assets. He then deducted patient prepays as a liability (over $1.1 million), for a final practice value of only $126,905. The husband's second expert was a broker; he said the excess earning approach was not normally used to value professional practice goodwill. Instead, he used two industry rules of thumb, a multiplier of net income and a multiplier of gross revenues, to reach a value between $1.3 and $1.5 million. He did not deduct patient prepays, and though new patient starts were important, he said, he had not received this information from the husband. (The court opinion does not explain why.) On learning that the husband received 866 new starts that year, the expert was "visibly shaken," saying that would make a buyer "clap his hands." The trial court found that the husband's two experts effectively impeached each other, on the use of an appropriate methodology and patient prepays. The second expert also lost credibility when he showed such evident surprise on the stand. The court accepted the wife's expert value, reducing the cap rate to reflect the practice's "substantial" dependence on the husband's skills. This led to a goodwill value of $1.9 million, or roughly midway between the three experts' numbers—and the husband appealed. "There is no absolute rule specifying how goodwill of a particular practice should be valued and any reliable method is acceptable if warranted by the facts," the appellate court held, stating the broad rule, applicable in most jurisdictions. Indeed, the excess earnings approach, discredited by the husband's second expert but utilized by his first (and the wife's expert), "is a method that is commonly used to determine the value of goodwill in a professional practice." In this case, the evidence amply supported the trial court's determination, especially given the lack of consistency, information, and agreement among the husband's two experts. Good use of rebuttal expert. Compare Helfer v. Helfer, Inc., 2009 WL 3644001(W. Va.)(Sept. 9, 2009), in which the husband also retained two experts to value his solo chiropractic firm, using the first as a primary witness and the second only in rebuttal. The first used a straight excess earnings and cost approach, to value the practice at $41,000, excluding any goodwill. In contrast, the wife's expert used the same approach to value the practice at $388,000, finding "some" practice goodwill, including the value of its location, facilities, telephone numbers, patient lists, and other data. However, he also acknowledged that clients and revenues had recently fallen and failed to assign a specific dollar amount to the practice goodwill. Interestingly, the husband's rebuttal witness criticized the excess earnings method, because in this case, the firm's liquid assets (cash and accounts receivable) were already subject to marital distribution. Further, the wife's expert failed to obtain a tangible asset appraisal, relying instead on the wife's opinion that they were worth over $53,000. By comparison, the husband's expert followed IRS guidelines to calculate their depreciated value at less than $7,000. The wife's expert also failed to consult comparative salary data or the parties' income tax returns to estimate reasonable compensation, using small business studies instead. He also noted the firm's "great location" in his goodwill calculation, but pegged its rental cost at only $10 per square foot (compared to $18 by the husband's expert), which effectively raise earnings. In fact, the practice goodwill had no value, the rebuttal expert said, and the trial court agreed, valuing the practice at $41,000. On appeal, the wife claimed the husband's primary expert failed to calculate any value for goodwill; likewise his rebuttal expert failed to provide an independent value. Thus the trial court erred by relying on the combination of testimony to assign a zero value to goodwill. The rebuttal expert reviewed both expert reports, however, and was "clearly knowledgeable" with their calculations, the appellate court held. Moreover, he clearly detailed the "serious" flaws in the wife's expert calculations and the more credibility findings by the husband's primary expert, including the lack of excess earnings. Based on this consistency among experts, the trial court was well within its discretion to conclude a zero value for goodwill.
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